Tuesday, December 29, 2009

As I was considering this year-end summary, it struck me that 2009 seemed to span more than a single year. It began with the economy plummeting with no obvious bottom in sight and energy demand falling with it. Later, as the financial system stabilized and the psychological impact of stimulus efforts in the US, China and the EU took hold, markets began to recover and the nascent depression became a nasty recession that apparently ended in the 3rd quarter. However, in a reversal of last year's dynamic, energy was mostly driven by the economy, instead of the former driving the latter. And unlike 2008, when oil grabbed the most headlines, the big energy stories of this year concerned natural gas and renewables, along with efforts to reduce emissions of the greenhouse gases that accompany most energy use.

For oil prices, 2009 was certainly two years in one: A weak first half in which the price of West Texas Intermediate Crude averaged just under $52 per barrel, and a much more stable second half averaging around $72. Nor did prices exhibit anything like their volatility of 2008, which started in the $90s, peaked near $150, and ended in the $40s after a dip to the low $30s. By comparison, 2009 looked more like a continuation of 2006 or 2007, as if 2008 never happened, but with the primary focus inverted from concerns about supply to worries about demand. It'll be a few months before the final figures are in, but it appears that global oil demand was down by 2% vs. 2007, with demand in the US off by a whopping 10% through September.

The impact of weaker demand on the refining sector was particularly severe, compressing margins and forcing the permanent closure of at least one major US refinery. The average US gasoline price for the year was nearly $0.90 per gallon lower than in '08, saving the average driver around $35 per month. The even larger savings in the first half probably constituted the most meaningful stimulus that most consumers were seeing at that point.

If the oil news centered on weak demand and OPEC's efforts to restrain supply, for natural gas it mainly highlighted the remarkable resurgence of US gas production, thanks to the shale gas revolution. If this trend can be sustained it has significant implications for the entire economy and for the emissions we produce. It also poses a serious dilemma for environmentalists, because the shale gas bubble and its benefits for climate change would evaporate if the drilling practice called hydraulic fracturing were to be banned or severely restricted. Also at stake is the potential revival of the US petrochemical industry, which relies much more heavily than its foreign competitors on natural gas as a feedstock, instead of oil. The jobs involved might not be exactly "green", but they are certainly desirable ones, in the sense of providing above-average wages. Government regulation of gas drilling and other aspects of the energy industry will be the trend to watch next year.

Speaking of government influence, it was crucial to the survival of the renewable energy industry in 2009. Aside from the strong vote of confidence and hefty financial commitment to renewables embodied in the stimulus bill, government grants to renewable energy developers stood in for the frozen "tax equity" market on which developers had previously relied to help finance wind farms and other facilities. US wind power capacity is on track to grow by around 28% this year to roughly 33,000 MW, though even at this impressive level it will still contribute just 2% of net electricity generation, for which the bigger story this year was the more than 10% drop in coal consumption, mainly at the expense of lower demand and higher gas-fired generation. Solar power is growing by leaps and bounds, though it still has a ways to go to catch up with wind and has already started to attract a similarly mixed reception as it moves beyond rooftops into utility-scale installations.

Meanwhile, another big renewable energy sector was kept on life support by the steadily-expanding US Renewable Fuel Standard and a 30-year-old subsidy that has outlived its usefulness. Despite this support and an import tariff designed to confine that subsidy to US producers, 2009 continued the previous year's trend of ethanol suppliers going bust. It also saw the largest of the previous year's ethanol bankruptcies progress to liquidation, as most of VeraSun's facilities were ultimately absorbed by independent refining giant Valero, which also became an active investor in next-generation biofuel technology. Yet in spite of its continued growth and the unwavering support of federal and state governments, corn-based ethanol is hurtling toward a collision with the 10% limit on blending it into a shrinking gasoline pool--a limit that ethanol supporters want to have raised to 15%, regardless of the consequences for consumers. An even bigger problem lurks for corn ethanol, which has lately been promoted for its contributions to reducing emissions. The evidence is mounting that on a global basis its emissions might even be worse than from the petroleum products it displaces. The greater our commitment to addressing climate change and sustainability, the larger the contradictions of corn ethanol will loom.

And that brings us to Copenhagen, which served as the year's great energy anti-climax. While the outcome is being touted as a "Big Step Forward," the session in Denmark failed spectacularly to deliver the expected culmination of the two-year timeline set at Bali and built upon in a series of interim meetings. Instead of a binding global treaty to replace the expiring Kyoto Protocol, the Copenhagen Accord looks like a joint promise to make a list of independent targets--a promise that was only purchased with commitments for future aid that may never materialize, or that may only come at the expense of existing forms of aid to the developing world. With action on climate legislation in the US Congress stalled for now--for good reasons, in my view--that was probably all that could realistically be accomplished. Yet it still falls short of any objective metrics for judging the session, and indeed the entire Conference of the Parties (COP) process. I wouldn't be surprised to see the COP marginalized by the Major Economies Forum, an initiative that adds the EU central government to the group of large emitters first convened by the previous administration. When the COP manifests the dysfunctionality of the UN General Assembly, then climate change needs its own version of the Security Council to get things done.

Neither Copenhagen nor Climategate spells the end of action on climate change, but they might just mark a turning point toward a more pragmatic and less dogmatic set of responses, perhaps along the lines of a compromise being floated in the US Senate that would consider the contributions of all forms of energy to a more secure energy future with lower emissions. That aligns with the gradual replacement of a narrative of oil scarcity by one of natural gas abundance and the deft use of renewables, with a much stronger emphasis on efficiency and conservation, which still look like the low-hanging fruit for both energy security and climate change.

Barring major events, this will be my last posting for the year. Best wishes for a happy and healthy New Year.

Monday, December 28, 2009

As I noted at the end of last Tuesday's posting, Haloscan, the comment system I've relied on for this blog since 2004, is being discontinued. After searching for alternatives that would both provide a simple interface for new comments and preserve the thousands of old comments here, I've decided to upgrade to Echo, the successor to Haloscan. The migration of old comments could take several days, though new comments should be in Echo format starting immediately.

I intend to customize the comment interface to make it as easy as possible for you to say what's on your mind. That might not be quite as simple as with Haloscan, which had flaws and quirks of its own. At a minimum, you may have to choose between inputting some information to show up as other than "Guest" or logging in with a "social media" account such as Twitter, Facebook, etc.

I'll do what I can to make this all seamless, including allowing comments to appear before they've been moderated, as before. In the meantime I'll ask for your patience while I sort out any bugs. Hopefully, the biggest change to get used to will be seeing the newest comment at the top of the thread instead of the bottom, and everything else will be an improvement. I look forward to your continued feedback on my postings, and on how the new comment system works.

Tuesday, December 22, 2009

While not the most powerful of the greenhouse gases produced by humanity, CO2 is certainly the most prevalent, if you don't count water vapor. To a very large extent, addressing climate change depends on three main strategies for dealing with the excess CO2 our activities emit: avoiding its creation by switching to other energy sources, such as renewables or nuclear power; capturing and storing it in trees, other vegetation or underground; and recycling it into useful fuels and products. Most of the work to date on the third option has focused on biofuels, which employ photosynthesis to convert CO2 into vegetable oils or fermentable sugars. However, another strategy now attracting interest involves non-photosynthetic pathways for turning CO2 back into hydrocarbons. If practical, this approach has much to recommend it, though the laws of Thermodynamics suggest it will always require more energy than the resulting fuels can deliver when used. A recent conversation with the CEO and CTO of Carbon Sciences, Inc., a start-up pursuing CO2-to-fuel technology, shed some interesting light on the subject.

The magnitude of global emissions of CO2 makes managing them a daunting prospect. Carbon Capture and Sequestration (CCS), which creates an artificial carbon cycle, has garnered much political and financial support in the last year, though it is still in the development stage and faces significant hurdles. CO2-to-fuel conversion offers another interesting option, because it could either work in parallel to CCS to enhance the reduction of emissions from fossil-fuel power plants and other stationary sources, or in competition with sequestration as an outlet for the captured CO2 from such facilities. If the resulting synthetic fuel displaced a like quantity of petroleum, natural gas or coal, the effect on the atmosphere would be largely equivalent to CCS and likely better than conventional biofuels, which appear to result in substantial non-combustion releases of CO2 and other GHGs. Fuels produced from recycled CO2 could finesse many of the NUMBY concerns about CCS while beating corn ethanol and some biodiesel on overall "green-ness" and compatibility with existing fuel infrastructure and transportation fleets. So why aren't we already doing this?

The answer is simple. When we burn the carbon compounds found in fossil fuels, they produce CO2 and a specific quantity of energy that is unique for each molecule. Turning CO2 back into the original fuel compound requires the input of that same amount of energy--that's from the First Law of Thermodynamics--and in practice a bit more, thanks to the Second Law. Chemists have known for a long time that CO2 could be converted into fuel and chemicals, but outside the laboratory this wasn't regarded as useful, because it inherently consumed more energy than it could return. Biofuels get caught up in this same conundrum, though in their case much of the energy required is supplied by the sun, rather than from other fuels and energy inputs we must produce. So I was quite intrigued when I received an email inviting a conversation with the CEO of Carbon Sciences, the start-up I mentioned earlier, which claims to have solved this problem using "biocatalysts", nanotechnology, and a unique multi-step process.

The company's website includes animation showing how this would work, though from my perspective it omits the key factor: where does the energy come from to drive the process? Catalysts and enzymes can reduce the threshold for the reaction to take place and improve its speed--the reaction kinetics, in engineering terms--so that what would otherwise take nature years or millennia to produce can be accomplished in a commercially-practical interval. However, catalysts can't alter the basic energy requirement of the reaction. What is the source of that energy?

My discussion with Carbon Sciences' CEO Byron Elton and Chief Technology Officer Naveed Aslam, Ph.D. assuaged my immediate concern that this was yet another perpetual motion machine dressed up with technical jargon and fancy graphics. They struck me as pragmatic and realistic about the challenges they face, though with the customary optimism required for entrepreneurial risk-taking. Dr. Aslam clarified that their process for converting CO2 to methanol for later conversion into hydrocarbons or petrochemicals involves a hydrogen-and-energy carrier molecule that must be regenerated from a "sacrificial substrate." That substrate effectively provides the energy required for uplifting the CO2, which is at a very low energy state, and acts as the fuel source for the whole sequence. The value of the entire CO2-to-fuel process in energy, economic and emissions terms thus hinges on the characteristics, cost and supply potential of this energy-donating material.

The process developed by Carbon Sciences can apparently use a variety of substances for this purpose, which is fortunate. Initial laboratory tests apparently involved glucose, a commercially-available sugar, but the company is now using another, undisclosed feedstock because of their concerns that glucose supplies couldn't keep up with a large-scale CO2-to-fuel industry without affecting food prices. Dr. Aslam indicated that in the long run they would likely use a mineral-based compound that was widely available. Without knowing the specific chemical involved, it's impossible to assess the overall energy balance, lifecycle emissions, or usefulness of the process, but I at least came away with a sense that Mr. Elton and Dr. Aslam understand the constraints involved very well.

And while the global supply of CO2 certainly looks large enough, it has to be provided in the right form: highly concentrated and free of contaminants that could degrade their catalyst or retard the reaction rate. That is a very different requirement from biofuels that extract their CO2 from the air, and it would put CO2-to-fuel in direct competition with carbon sequestration and enhanced oil recovery, which also effectively produces incremental fuel from CO2. It's not obvious to me which technology will advance the fastest, offer the largest overall CO2 reduction, or the most attractive economics. Markets are usually the best way to sort that out, if given the right signals.

Nor are Carbon Sciences the only ones working on this problem. A team at Sandia Laboratory has been developing a "Sunshine to Petrol" system using CO2 and concentrated sunlight, while the new Advanced Research Projects Agency-Energy (ARPA-e) is looking into a variety of novel ways to convert CO2 into fuel without photosynthesis.

It's important to note that Carbon Sciences' conversion technology is still at an early phase of development--lab-scale, rather than demonstration-scale. "Milliliters per day" won't solve our energy or emissions problems, but if this can be scaled up to many thousands of barrels per day with a cheap and readily-available source of chemical energy and a suitable supply of CO2, it has the potential to deliver fuels that are 100% compatible with our current infrastructure and vehicle fleets. That's a big advantage, and it would certainly explain the interest that Carbon Sciences has apparently been getting from large energy firms. I was told that Carbon Sciences hopes to develop a commercially-attractive package by the third quarter of 2010 and are exploring a "strategic partnership" to take the process--and the company--to the next phase. They have also applied for DOE technology funding under the category of "Innovative Concepts for Beneficial Uses of CO2". I will be watching their progress with great interest.

Since I don't expect to post again until next week, I'd like to wish my readers a Merry Christmas and happy Boxing Day. I also have a housekeeping matter to bring to your attention. Haloscan, the comment system I have used since 2004, is being discontinued. I must decide by Monday whether to switch to Haloscan's successor, Echo, use Blogger's comment feature, or find another comment platform. Although I will do my best to ensure the migration of the many thousands of comments you've left here, I can't guarantee it. If there are any you'd like to refer to again, I encourage you to copy them to another medium.

Friday, December 18, 2009

While the Copenhagen delegates, which now include many heads of state, wrangle about transparency and the size and funding of the pot of money that will be required to assist the developing world in mitigating its emissions and adapting to further climate change, another debate over transparency is brewing. Its range of potential outcomes is wide. At one end it entails a collision between science and the law--two less compatible spheres would be hard to imagine--over the issues raised by the emails and data leaked from the University of East Anglia. At the other extreme concerns about "Climategate" will gradually fade from our consciousness in the manner of Tiger Woods's fall from grace, but perhaps not without raising some interesting questions along the way.

To appreciate how matters might unfold, check out an op-ed in today's Wall St. Journal from Dr. Patrick J. Michaels, a climate scientist on the receiving end of some of those barbed emails revealed by the leak. In addition to calling into question the neutrality of the peer review process that underpins the science upon which the Copenhagen talks and any agreement that comes out of them are based, he provides a hint at the form that future legal challenges to the enforcement of such an agreement, or of rules arising from the EPA's recent endangerment finding, might take. These allegations are serious, particularly when you consider that Dr. Philip D. Jones, until this month the head of the Climate Research Unit at East Anglia, was also one of two Coordinating Lead Authors of Chapter 3 of the Fourth Assessment Review of the Intergovernmental Panel on Climate Change (IPCC.) That chapter (very large file) deals with actual observations of "surface and atmospheric climate change", including the temperature data. That makes him a key gatekeeper of the consensus.

I only ran across that connection, because I've been following a side debate concerning how actual temperature measurements at thousands of locations around the world over the last century have been tabulated. The barely civil online point-counterpoint between an anonymous blogger at The Economist and the proprietor of a well-known climate skeptic website gives a flavor for this complex topic. Along the way I was surprised to learn how frequently the actual temperature readings are adjusted, interpolated, and in some cases discarded. This involves many assumptions that I'm not qualified to question, though I am left with the conclusion that recent temperature trends fall into much the same category as the pre-measurement historical temperatures reconstructed from proxies such as tree rings. In other words, the familiar temperature trend graphs reflect mainly analysis, not primary data. That puts us all in the position of having to trust that this analysis was done properly and neutrally, and unfortunately that is precisely the trust that the leaked emails have undermined.

In a recent New York Times op-ed, Stewart Brand, an iconic figure and an acquaintance from my former work with Global Business Network when I was at Texaco, proposed a useful taxonomy for our reactions to climate change. He suggested four categories into which those with an opinion on the subject fall: Denialists, Skeptics, Warners, and Calamatists. The views of those in the first and last categories aren't likely to alter much, no matter what science and further evidence reveal about the climate. What they see reinforces pre-existing mindsets. The Skeptics and the Warners, on the other hand, are part of a legitimate scientific debate and are both amenable to adapting their views to new evidence.

I consider myself mainly a Warner in Stewart's terms, having consistently expounded the risks of climate change both in this blog and elsewhere, but I am still willing to give both sides of the argument a fair hearing. I want to see Climategate addressed openly and objectively. If the science turns out to be flawed because of bias and improper manipulation, we need to know that and correct the flaws. If the actual science is unaffected, but the means by which it has been conducted requires reform, then we need to address that as well, because if we don't the public's confidence in its findings won't be high enough to act on them. And I'd rather see this hashed out in an open scientific forum held by a body such as the AAAS and involving many disciplines outside climate science as a true jury of peers, than to see it resolved by litigation, which is where this all could be headed if scientists respond by shrugging it off or circling their wagons.

Wednesday, December 16, 2009

I missed commenting on the latest round of oil deals in Iraq, which could see that country's output quickly double and eventually quadruple, causing no small amount of anxiety within OPEC. It's looking increasingly likely that the world may need that oil sooner rather than later, though. While the backdrops of photos from Copenhagen display the "tck tck tck" mantra symbolizing the conference as our last, best chance to avert catastrophic climate change, we shouldn't forget that another clock with a shorter timeline is also ticking down on our last chances to prevent Iran from developing nuclear weapons.

Business leaders are often advised not to let the urgent drive out the important. Although climate change has been billed as having both attributes, so do Iran's nuclear ambitions, and their implications in the next decade take urgency to a higher level. Yesterday's Washington Post featured a chilling analysis of the progress Iran has been making on fronts other than the Uranium enrichment that has attracted so much attention. This includes a leaked memo from the International Atomic Energy Agency assessing Iran's capabilities and another purportedly from inside Iran showing that the government is working on a "neutron initiator." If these assessments are right, then the controversial National Intelligence Estimate of 2007 placed far too much faith in indications that the regime had decided to cancel work on a warhead. Our subsequent patience with them--and with our Security Council partners--has provided Iran with crucial time in which to advance its goals.

While we were in a poor position to ratchet up the pressure sufficiently in 2007 or 2008, when Iran's oil exports made the difference between high oil prices and a crippling oil shock, that constraint disappeared last fall. The combination of OPEC's current spare capacity of at least 6 million barrels per day and the prospect of Iraqi output increases that could dwarf Iran's exports has largely neutralized the threat of an Iranian embargo, perhaps permanently.

Now, it's still possible that the visible parts of Iran's nuclear efforts are a sham mounted mainly for our benefit, similar to the double feint concocted by Saddam Hussein, in which he claimed not to be doing something while doing just enough behind partially-closed doors to make that claim look false. In retrospect that strategy made a certain amount of sense for Iraq, which after its defeat by Coalition forces in the Gulf War could not have defended against a conventional attack from the larger neighbor it had fought to a standstill a decade earlier. However, it makes little sense for Iran, which already has powerful defenses and a wide array of weapons and allies with which to retaliate in case of an attack by the US, the only power that could seriously threaten it at this point.

If the op-ed in the same issue of the Post is correct about the difficulties of mounting effective deterrence once Iran has the Bomb, then we don't have much time left to exercise the remaining diplomatic and economic options in our playbook. That means assessing the positions of Russia and China with a gimlet eye and determining for ourselves whether they would ever sacrifice their trade and security connections with the Islamic Republic, in order to forestall nuclear developments that they likely see as not aimed against them in any case. As weak as our hand looks now, it will only get worse later. In the context of this countdown, today's relatively high inventories of crude oil and refined products look like a very good thing.

Monday, December 14, 2009

Although apparently brief, the suspension of the Copenhagen climate conference after a walkout by the Group of 77 developing countries confirms that the talks are as much about money as about healing the world's climate. It's not just that the G77 wants the Kyoto limits on the emissions of developed countries enforced, while leaving their own emissions uncapped; it also wants the developed world to kick in sizable sums--much bigger than the 2.4 billion Euros per year offered by the EU--to cover the improvements in energy efficiency and renewable energy that would enable them to tackle the growth of their own emissions. There's a solid argument there, though it is not the guilt-based logic of "carbon debt" that I explored a few weeks ago.

An op-ed in the Saturday Wall St. Journal got me thinking about this issue over the weekend, before the G77 delegates walked out of the COP-15 session in Copenhagen. This commentary by a Berkeley physics professor and author of "Physics for Future Presidents" was bursting with enough ideas to stimulate a dozen blog postings, but its key insight was that even the massive cuts in US emissions proposed for mid-century would be of little or no consequence in curbing global emissions that are increasingly concentrated in the developing world. He suggests that the emissions of developing countries will count the most, and that these countries will only adopt emission cuts that provide clear economic benefits to them. In that context and under the current Kyoto-based framework, the strongest argument for imposing deep cuts on the US and EU is not the reduction of our own emissions--which would have a minimal direct impact on the expected increase in the earth's temperature--but the role of these cuts in creating a market for offsets generated by investments in emission-reduction projects in the uncapped developing world via the Clean Development Mechanism, or CDM. Unfortunately, this logic has already led to notable distortions of the intent of the CDM.

There has to be a better way. As Dr. Muller notes, "A dollar spent in China can reduce CO2 much more than a dollar spent in the US." Yet US voters won't countenance providing that dollar out of guilt, nor will they acquiesce to a scheme that makes China and other developing countries more competitive at their expense. Paradoxically, even domestic measures such as European feed-in tariffs and the proposed federal Renewable Electricity Standard embedded in the Waxman-Markey climate bill could create such an outcome, if Chinese and Indian green technology firms come to dominate developed country green energy markets. There are already indications of this happening in the German solar market.

Instead of the technology transfer we've been talking about for more than a decade, what may be needed is a new mechanism that actually creates markets in the developing world for clean energy hardware and know-how produced in the developed world, so that these projects create jobs and wealth in the US and EU, rather than threatening them. I'm not sure precisely what form such a deal might take, but at a minimum it should incorporate both open access to developing country markets and uniform legal protection for the physical and intellectual property of the developed-country companies making these investments.

The best thing that could come out of today's disruption at Copenhagen would be the cancellation of the big heads-of-state photo-ops planned for the final days of the conference and a determination to put the delegates back to work crafting a new agreement that creates the right recipe for focusing the lion's share of climate investments on the rapidly growing emissions of the third world, rather than on the shrinking emissions of the EU and the plateaued GHG output of the US. That would be something worthy of bringing the world's leaders together to sign.

Friday, December 11, 2009

The inclusion of support for expanded US oil and gas drilling in a Senate climate proposal issued yesterday is bound to puzzle many readers. If the emissions from oil are responsible for a major portion of human-induced global warming, how can increasing our production of it contribute to reducing US emissions, as the three Senators involved suggest? The answer requires a clear understanding of where most of the emissions in the oil value chain take place. It also invokes a broader view of climate and energy security that recognizes that oil is not as close to being replaced by renewables as we'd like to think, and that in the absence of higher domestic output, our oil imports could continue to increase, with consequences--and emissions--beyond our control.

The proposed framework from Senators John Kerry (D-MA), Joe Lieberman (ID-CT), and Lindsey Graham (R-SC) was released in the form of a letter to President Obama, outlining the parameters of a climate bill that would include emissions caps and market mechanisms--presumably cap & trade--plus support for nuclear power, clean coal, and oil and gas drilling, along with other provisions to protect consumers and promote job creation by helping manufacturers become more energy-efficient. In the absence of its details, the proposal looks broadly similar to other climate measures, including Waxman-Markey and Kerry-Boxer, but without treating domestic producers of conventional energy as undesirable elements. The trio behind this initiative is also interesting, adding Sen. Lieberman's long-standing credibility on cap & trade (3 previous Senate bills) and the bi-partisan participation of Sen. Graham.

To understand what support for domestic oil drilling is doing in a climate bill, however, you have to look at oil's continuing role in our primary energy mix and the distribution of emissions associated with its production, refining and use. Start with primary energy, with oil accounting for 37% of last year's total US energy consumption, in the form of 19.5 million barrels per day (mbd) of crude oil and refined products. Biofuels can't replace oil anytime soon, and even at its maximum extent in 2022, the entire Renewable Fuels Standard would only displace the energy equivalent of about 1.4 mbd of oil, or roughly 7% of current consumption. Nor can wind and solar power do the job; they will be fully engaged in reducing the average emissions of the US electricity mix, only about 1% of which is generated from oil. Some of that green power will eventually find its way into electric vehicles, which do displace oil, though these aren't likely to make up more than a small fraction of the US car fleet for decades. In any case, the emissions from biofuels and electric vehicles may not be that much less than from oil use.

The inescapable conclusion is that the US will continue to burn oil for a long time. The quantities will decrease as efficiency and substitutes ramp up, but not fast enough to back out all of the oil we import for a very long time, let alone all petroleum from all sources. And that's where the energy security aspects emphasized by the three Senators come in; if we're going to need oil for years to come, as much of it as possible should be produced here.

Then there are the emissions from that oil. When assessed on a full lifecyle basis, most of the emissions from petroleum occur when it is used, not when it is produced. That's even true for oil derived from oil sands, which entails significantly higher upstream emissions than for the conventional oil output this framework would promote. Depending on the crude oil source and the products involved, well-to-wheels analysis suggests that 80-90% of emissions occur at the point of use, with production, transportation and refining accounting for the much smaller remainder. As a result, the point of maximum leverage on the emissions from the oil value chain is not exploration & production, which accounts for only a few percent of emissions, or refineries that are already 90% efficient, on average, but the cars and other vehicles and devices in which we consume it. The most effective strategies for reducing oil-based emissions thus involve vehicle dieselization, hybridization, downsizing, and other efficiency measures, along with non-efficiency conservation, including carpooling, telecommuting, virtual meetings, etc.

Moreover, since climate change is inherently global in nature, it doesn't matter whether the upstream emissions associated with oil occur in the Gulf of Mexico, the Persian Gulf, or anywhere else, except to the degree that domestic conventional oil might displace oil from higher-emitting unconventional sources elsewhere. But while the sources of the oil and refined products we use are largely irrelevant from a climate change perspective, they are most certainly relevant to our energy security. Increasing domestic oil production would pay big dividends in tax revenue, job creation, and the reduction of both our trade and fiscal deficits. (Disclosure: My personal investment portfolio includes oil stocks.)

The Houston Chronicle quoted Senator Graham as saying, "There will be no bill with Lindsey Graham's vote if it doesn't have meaningful offshore and onshore exploration." If he represented Alaska, Louisiana or Texas, you might attribute that sentiment to a desire to protect his home state's energy interests. Instead, it reflects a practical reality that seems to have escaped many in the administration, who appear to equate all oil from all sources with environmental and economic ills, rather than realizing that while we all know we need to use less oil for many reasons, that doesn't preclude us from using more of the enormous oil endowment with which the US has been blessed. If we use it wisely, domestic oil can provide a necessary bridge to the clean energy future we all want, and in a manner that is consistent with reducing global greenhouse gas emissions. I don't know whether these three Senators have found the recipe for breaking the Senate impasse over climate change, but this proposal could represent just the kind of grand compromise on energy and the environment that we have needed for a long time.

Thursday, December 10, 2009

As the nations represented at Copenhagen debate proposals for reducing their absolute emissions or carbon intensity, I was reminded that we shouldn't just focus on the percentages being offered, but also on the reference year emissions on which these proposals are based, since these aren't necessarily comparable. That's particularly true for the US and EU, which have consistently referred to 2005 and 1990 base years, respectively. This distinction is crucial in understanding how much of what each party might commit to has already been achieved and how much remains to be accomplished.

Start with the EU, which has proposed a reduction of 20% versus its 1990 emissions levels. Based on a recently-issued report by the European Environment Agency, the 27 countries constituting the European Union today have already reduced their emissions by 10.7% as of last year, compared to 1990. According to this report their collective emissions in 2005 were 9.3% below 1990, so that 20% figure for 2020 really translates to roughly 12% below 2005--and only a bit more than 10% below where they are now--which is substantially less than the 17% reduction that the US has put on the table. However, the US proposal should also be put into context, because of the divergent emissions trends of the two regions since 1990, which was the base year for the Kyoto Protocol that has guided EU policy in the intervening years, but which the US never ratified.

Between 1990 and 2005 total US greenhouse gas emissions increased by 16.5%. After counting net emissions including all sources and sinks--mostly natural processes such as forestry that absorb these gases--the increase was about 14%. So either way, that 17% cut that US negotiators were authorized to take to Copenhagen is really 1990 less about 3-5%. At the same time, 17% vs. 2005 is no slam dunk, even if it appears that the recession helped ax 2% of our emissions as of last year, and this year could be down a bit more. A recovering economy will use more energy and emit more GHGs, even if only from the work commutes of millions of re-employed people.

While I don't expect nearly as much controversy over the choice of baseline years as surrounded the Kyoto negotiations, 1990 and 2005 represent very different worlds, with the former largely pre-dating the collapse of the high-emission Soviet bloc economies, giving rise to all those Russian "hot air" allowances and a major portion of Germany's cuts post-reunification, along with a big shift in UK power generation away from coal and toward natural gas. Although the EU has certainly instituted comprehensive policies to reduce its emissions, including a cap on industrial emissions and a union-wide Emissions Trading System, a large chunk of the reductions for the current membership were achieved before any of these policies went into effect, through the rationalization of the inefficient economies of formerly-communist Central and Eastern Europe. 1990 looks even less relevant to the current economies of large developing countries like Brazil, China and India.

On the other hand, while 2005 has much to recommend it as probably the most recent year for which fully-audited emissions data are available globally, it also represents nearly the high-water mark of a world of easy money and massively-globalized supply chains that may never return in quite the same form. Choosing it might also appear to let the US off the hook for a decade of relative inactivity on climate change, though that ignores the fact that our actual emissions have grown by much less than the 33% business-as-usual increase that was expected in the late 1990s, presumably because of the discipline imposed by the steadily-rising energy prices that accompanied our bubble economy of recent years.

Whatever emerges as the baseline for an agreement or framework coming out of Copenhagen, it ought to be a single year that provides both ease of comparison and a reasonable congruence with the realistic starting point for any actions that countries will commit to undertaking in the years ahead.

Tuesday, December 08, 2009

It wasn't supposed to turn out this way. When delegates to the climate conference in Bali in December 2007 agreed on a two-year roadmap culminating in Copenhagen this week and next, they were widely understood to be buying time for the US to elect a new administration committed to much stronger action on climate change, for the remaining scientific uncertainties to be resolved, and for the large developing countries to be brought around to make binding commitments regarding their own growing emissions. Yet while progress has been made on all three fronts, the changes over the last couple of years have manifested in ways that still don't quite deliver the scenario necessary to set up Copenhagen to deliver on all of Bali's promises.

As I noted during the run-up to last year's election, both major US political parties chose nominees who had made climate change a central issue of their campaigns. Neither an Obama administration nor a McCain one was going to look much like its predecessor on this issue. Yet we've also seen that the partisan differences on climate change reflect deeper underlying concerns about the impact of greenhouse gas regulations on parts of the economy that aren't evenly distributed across the states, some of which rely much more than others on the production or consumption of the highest-emitting fuels, particularly coal. Those economic concerns loom larger after what we've been through in the last year or so. Together with the inability of recent Congresses to refrain from festooning every piece of major legislation with grab bags of peripheral regulations and pork, this resulted in a badly flawed House bill on cap and trade--and much else--and a Senate counterpart that is starting to look dead on arrival. With President Obama needing to arrive in Copenhagen armed with more than empty promises, we now get an anything-but-coincidental Endangerment Finding that could end up reducing emissions in the most costly way imaginable.

Then there's the science and even the climate itself, which has hardly cooperated in the two years since Bali. While this decade is still on track to be the warmest on record globally, 2008 was the also coolest year since 2000, and despite some rebound 2009 won't set any new records. And just when the science was looking settled, the emails and computer files hacked--or leaked--from a major climate research center in the UK have raised concerns about the peer review of papers questioning the consensus view, and about the processing of raw data for the "climate proxies" used to recreate historical conditions before the century or so that they have been observed accurately--data that incidentally provide key inputs to the climate models predicting the temperature and other outcomes from steadily increasing levels of CO2 and other greenhouse gases in the atmosphere. The likelihood that the timing of this leak is no more coincidental than that of the EPA's finding doesn't alter the need for these questions to be assessed by someone besides the scientists whose work was involved.

Then there are the large, rapidly growing emissions from China, India and other developing countries, especially when changes in land use are taken into account. As I mentioned the other day, China's announcement that it would reduce the carbon intensity of its economy as it grows is a big first step, but it also falls into the category of things necessary, but not sufficient, to induce the US to commit to deep absolute cuts, particularly in light of polling that suggests the US public is less worried about climate change than it was when the economy was booming a couple of years ago--again, no coincidence.

When I return from my current travels I'll be watching the news from Copenhagen with great interest. I expect to post more on this subject, as developments warrant.

Friday, December 04, 2009

In the last year or so the rationale for renewable energy has evolved from emphasizing mainly energy security and climate change to focusing on the creation of "green jobs" and the development of an industry that many perceive as the "next big thing": a new global growth wave along the lines of information technology and telecoms. Unfortunately, neither of these newer justifications withstands serious scrutiny. I've devoted several postings to the shortcomings of the green jobs angle, which founders on the mistaken notion that we should want an energy sector any bigger than the minimum necessary to furnish the energy needed by the rest of the economy. The IT analogy looks harder to dismiss, because it capitalizes on our innate affinity for technology, the newer and trendier, the better. I share that bias and have been fascinated by the technology of alternative energy since my undergraduate years. Yet as inherently cool as the devices for deriving energy from wind, tides, solar radiation, biomass, and exotic forms of nuclear energy are, that doesn't automatically set them up to be the next world-transforming and wealth-creating industry in the manner of IT in the 1980s and '90s.

Understanding where this analogy fails requires delving into the drivers of the IT revolution. It wasn't just that technology was improving by the quantum leaps in processing power and decreased cost described by Moore's Law. Nor was it merely the result of nebulous "market forces", though the market's ability to deploy capital nimbly to the cleverest entrepreneurs helped a lot. Fundamentally, IT took off and continues to grow because it spurred breathtaking improvements in productivity and innovation, not just within the computer industry itself, but more importantly across the entire economy. IT enabled the automation of numerous manufacturing processes, the discovery and exploitation of vast new energy resources, and the launch and sustained growth of entirely new industries, including cellphones, personal electronics and the Internet. Yet while renewable energy holds great potential for reducing our emissions and our unhealthy reliance on imported oil, it cannot offer the kind of productivity revolution that IT delivered.

Start with the fact that most forms of alternative energy are still uneconomical without government incentives or mandates. If you doubt that, recall that new US installations of wind power, which is generally regarded as the most cost-competitive of the newer alternative energy technologies, were on the verge of grinding to a halt when it appeared that the Production Tax Credit might not be renewed at the end of 2008, and again when the markets for translating those tax credits on future earnings into current cash froze up earlier this year. The wind sector only revived when the government provided a substitute Investment Tax Credit and made it available in the form of direct grants from the Treasury.

Now, there's a strong argument that these incentives are necessary to compensate for the inherent advantages of fossil fuel-based power generation that doesn't pay for the environmental externalities it creates. However, that doesn't alter the fact that the expansion of this industry is not being driven by the underlying wealth-creating force of productivity improvements, but by government funding and regulations. Thus much of the growth of the alternative energy sector comes at the expense of other parts of the economy, or of larger deficits that impair the long-term health of the economy. That might be necessary, but it won't create vast new wealth in the way that IT did.

In fact, as long as wind, solar and other forms of renewable energy require government support or mandates such as Renewable Portfolio Standards to keep them growing, they will tend to reduce the overall productivity of the economy by embedding higher energy costs into everything we do, whether those costs are reflected directly in higher energy prices or indirectly in higher taxes or bigger deficits. Meanwhile, less glamorous technologies associated with energy efficiency offer genuine productivity improvements today and well into the future, though probably still on a smaller scale than those wrought by IT, since energy accounts for only about 8% of GDP. I'd put the electrification of transportation into this efficiency category, too, once the cost and capability of batteries improve enough to make them attractive without massive subsidies.

Renewable energy looks likely to continue its impressive growth, building new companies and making fortunes for some entrepreneurs. It has great potential to contribute an important share of our future energy mix. Unlike IT, however, this transformation will largely be limited to the energy sector, with relatively little impact beyond it. Devices that consume electricity won't run any better on green electrons than on any other kind, and engines won't suddenly begin performing at higher levels on renewable fuels--in fact, the opposite is often the case. So rather than sugar-coating the green energy proposition with inflated claims that are likely to lead to disappointment later, a dose of stoicism seems to be in order, here. If accelerating the growth of renewable energy is the right thing to do for the planet and for our energy security, and if its long-term benefits outweigh the costs, we should dispense with the hype suggesting it will make us all rich and just get on with it.

Wednesday, December 02, 2009

When I wrote Monday's posting mentioning the impending conflict between the government's requirement to increase the volume of biofuels blended into gasoline and the current approved maximum ethanol blending limit of 10%, I was unaware that the EPA was about to issue a response to the industry group that had requested a waiver to increase that limit to 15%. But while the letter the agency sent to Growth Energy yesterday deferred any ruling until mid-2010, it gave a clear indication that the EPA is considering splitting the baby, in the form of an increase for part of the fleet: those cars built in 2001 or later. Sometimes such a quasi-Solomonic decision reflects wisdom and flexibility; at other times it elevates compromise above common sense. I'm sure you won't be surprised to learn that I suspect this case falls into the latter category.

First, we should applaud the EPA for declining to be stampeded by an interest group into making a decision before its own test results are all in, particularly concerning the impact of blends containing higher proportions of ethanol on the durability and emissions (air pollutants, not CO2) of a representative cross-section of the US vehicle fleet, which numbers roughly 240 million passenger cars and light trucks/SUVs. The agency is right to insist that the science should be clear before the blending limit is increased. Unfortunately, there's more than science involved.

If any group outside the energy industry ought to have a clear understanding of the consequences of fragmenting the marketplace through the creation of Balkanized environmental specifications for fuels, it ought to be the EPA, since they and their state regulatory counterparts have presided over just such a system in the last couple of decades. This is why gasoline blended for use in Oregon or Washington can't be sold in California, and gasoline blended for rural areas can't be sold in metropolitan areas that have been designated as "non-attainment" areas for ozone and other pollutants. This has a direct impact on consumers by raising the cost of suppliers' inventories and deliveries to areas with divergent specifications, and more significantly by delaying the response to local supply outages. If the EPA is seriously considering establishing two blending standards for ethanol, it would further fragment the fuels market, not along geographic lines, but down to individual service stations, because the likelihood of them all carrying Unleaded Regular (E10), Unleaded Regular (E15), Mid-grade (E10), Mid-grade (E15), and so on, in addition to diesel and eventually E85 and whatever else they dream up is essentially zero.

Let's rewind the tape for a moment to recall how the situation the EPA is attempting to address arose in the first place. When the Congress set the new Renewable Fuel Standard as part of the Energy Independence and Security Act of 2007, it was obvious to all involved that even if US gasoline sales had continued to grow at 1-2% per year, as they consistently had prior to the Great Recession, we would rapidly reach the point at which the quantity of ethanol mandated for use would exceed 10% of our annual motor fuel use--long before the mandate reached its 36 billion gallons per year (gpy) target in 2022, including a billion gpy for biodiesel. That wasn't deemed to be a problem, since E85 sales were expected to take off in a big way, soaking up all that extra ethanol. In fact, before it started to shrink the gasoline pool looked like it could accommodate the entire 35 billion gpy of ethanol with an E85 sales percentage as low as around 18%. Today you'd probably have to bump that up to nearly 25%. Unfortunately for this scenario, E85 sales are not on any kind of trajectory to reach that threshold.

One E85 website reports that 2,211 gas stations around the US sell E85. Finding reliable statistics on actual E85 sales is time-consuming, but if all these stations sold at the current Minnesota average of around 4,000 gallons per month, then total US E85 sales are just over 100 million gpy. That's less than 0.1% of US gasoline sales, or just about enough to absorb the output of one typical ethanol plant. These figures also suggest that the roughly 6 million "flexible fuel vehicles" apparently on the road today are consuming E85 less than 10% of the time, either because of availability, or because the average discount between E85 and gasoline is typically much less than the 25% or so necessary to compensate for its lower energy content. And availability is a function of the significant expenses involved for service stations in either converting an existing tank and pumps for a higher-volume product to E85, or investing in additional tanks and pumps--including the downtime involved in such a project.

In other words, the ethanol industry (and the EPA) are in a bind now because the strategy for increasing ethanol use hinged on the expansion of sales for a new blend of ethanol and gasoline that is incompatible with existing service station infrastructure and with most vehicles on the road, and their best solution to the breakdown of that strategy appears to involve introducing yet another new blend of ethanol and gasoline that is incompatible with existing service station infrastructure and many cars on the road. Using this logic, the answer to the financial crisis would have been to launch another wave of new financial derivatives and sub-prime loans. Perhaps it's time for a simpler answer: If the tests by the EPA and DOE indicate that a significant number of vehicles could be harmed by a 15% blend of ethanol in gasoline, or that such a blend would increase local air pollution, then surely it is time to call a halt to the annual increases in mandated ethanol use until a more practical solution can be found.

Monday, November 30, 2009

A couple of stories over the long weekend highlighted growing disconnects between major elements of energy and environmental policy and what is actually possible in the real world. The first concerns China's gambit that committing to a carbon-intensity target that could be met with initiatives already under way might be sufficient to induce the US and EU to sign up for deeper cuts in actual emissions--and incidentally release a flood of "carbon debt" payments from the OECD to the developing world. Meanwhile a pair of articles on ethanol highlight the infeasibility of the biofuel mandates established by the US Congress a few years ago and about to be embedded in new EPA regulations. In both cases, practical reality is at odds with the aspirations of regulators in ways that threaten to undermine support for less ambitious but more achievable efforts.

The Copenhagen climate meeting, officially the 15th Conference of the Parties to the UN Framework Convention on Climate Change, begins in one week. Politicians and diplomats have been scrambling to avert the possibility that after two years of work on the details of the framework set in Bali, the meeting might conclude without producing an agreement that could take the place of the Kyoto Protocol, which expires in 2012. Last-minute actions by the world's two largest emitters may have rescued the conference from this fate, in the form of a pledge by President Obama that the US will reduce its emissions by 17% below 2005 levels by 2020 and a commitment by China to reduce its emissions per unit of economic activity by 40-45% below 2005 levels. But while this might save Copenhagen from irrelevance, it illustrates how far the available degrees of freedom for action in countries that must keep their economies moving forward fall short of what would be required to halt the accumulation of greenhouse gases in the atmosphere and begin to reverse it.

As it is, President Obama is taking a considerable risk in offering emission cuts that have not been approved by Congress, which might not be inclined to stick out its neck quite so far going into a tough mid-term election that will hinge on the economy and employment. While China's offer represents a serious first step, a similar focus on "carbon intensity" by the previous US administration was met with derision by environmentalists. The problem is that the level of emissions this would yield if China's economy continues to grow at 8% per year or more is incompatible with scenarios for limiting peak CO2 concentrations in the atmosphere to 450 parts per million and eventually restoring them to pre-industrial levels. If we can't avoid blowing past the 450 ppm limit that was the basis of the Bali framework, then growing efforts to shift the official goalpost back to 350 ppm--a level we passed in 1988--look like King Canute ordering the tide not to rise. Expect a great deal of attention to be focused on these numbers in the next couple of weeks.

The disconnect on US ethanol policy is even more pronounced, because the current path can only be sustained for a few more years. An op-ed in Saturday's New York Times reminds us of the shortcomings of our current reliance on ethanol produced from corn, while comments by the CEO of Shell, a major investor in next-generation biofuels, makes it clear that the extremely ambitious targets for cellulosic ethanol and other non-food-based biofuels that the Congress mandated in the Energy Independence and Security Act of 2007 are extremely unlikely to be met. And even before that shortfall becomes serious, the nation's distilleries will exceed the capacity of current US motor gasoline sales to accommodate all the ethanol they can produce, unless the government also lifts the 10% blending limit.

While we can argue about whether that ought to happen, the bigger issue is that these two developments expose the failure of the key assumptions under which the Congress crafted the Renewable Fuel Standard: E85 has turned out to be a dud in the marketplace for good reasons--consumers have figured out that a fuel that costs more dollars to go fewer miles is a bad deal--and it turns out to be really hard to make fuels on a large scale or at an affordable cost from non-food biomass. The appropriate response when your expectations of the future turn out to be so badly wrong would be to freeze the status quo in place while revamping the standard to reflect more realistic assumptions, not to enshrine the false assumptions in new EPA rules that will drive up fuel costs for consumers without doing a thing to improve the environment.

Wednesday, November 25, 2009

Thanksgiving is a perfect time to reflect on the many energy blessings the US enjoys. While we tend to focus on our problems, which seem numerous and overwhelming at times, there are a number of positives we should also recognize. Here's a short list of them to contemplate over tomorrow's turkey dinner:

The US still produces roughly three-fourths of the energy we consume, well ahead of the EU and Japan, and with prudent investment in energy efficiency and new production of all kinds, that ratio could grow significantly over the next decade.

The energy efficiency of the US economy has been improving steadily. Measured in terms of BTUs per dollar of real output, our energy consumption per GDP has fallen by more than 15% in the current decade. That's one reason that our greenhouse gas emissions increased by much less than expected, even before the recession started.

Only a few years ago, the US natural gas supply and demand balance looked like a slow-motion train wreck. Thanks to a tremendous surge of production from shale gas reservoirs and other unconventional sources, US gas production last year reached the highest level since the mid-1970s. If the incremental production added since 2005 were all turned into electricity, it would equate to the output of 100,000 MW of wind turbines.

Despite the weak economy and extremely challenging financial markets, US wind power capacity is on a pace to grow by more than 7,000 MW this year, surpassing all but last year's record additions, and bringing total wind capacity by year end to over 32,000 MW.

US crude oil production looks set to snap a 17-year trend of annual declines. The API indicates that year-to-date 2009 production is up by 6.8% over last year, as major new projects initiated earlier in the decade when prices began to rise come on stream.

Finally, here's a non-energy statistic that surprised me. Even after contracting by 3% from last summer's high point, US real GDP has grown this decade by an amount that exceeds the entireGDP of Brazil, and our nominal GDP is up by an amount roughly equal to the entire economy of China. That shouldn't make us feel complacent, as both of those countries are growing at much faster rates than we are, but it should at least provide some perspective on the discouraging comparisons we're accustomed to hearing.

Energy Outlook will observe the traditional long weekend and resume postings early next week. Happy Thanksgiving!

Monday, November 23, 2009

For the last couple of days I've been ruminating about what to say concerning the emails and other data apparently leaked by hackers who penetrated the computer systems at the University of East Anglia's Hadley Centre Climate Research Unit, one of the major global sources of climate change data and analysis. It's clearly premature to attempt to draw sweeping conclusions about the implications for climate science and policy from the few tidbits that have been leaked to the press or published on the websites of leading climate skeptics, some of whom have already characterized the story as "Climategate." At the same time, it strikes me as naive--and perhaps ultimately counterproductive--of those in the "true believer" community who imagine that the publication of such interactions would not naturally lead to serious questions about the scientific basis of some very expensive proposed policy actions to address global warming.

Start with the official statement from the University of East Anglia. While I'm naturally sympathetic to their concerns about the breach itself and the resulting release of sensitive personal information of university employees, it is also worth recalling that the institution in question is funded by UK taxpayers and is not exactly covered by the Official Secrets Act. If laws have been broken, the perpetrators should be pursued and prosecuted. However, if university officials believe they can confine their response to the theft of data and easily dismiss the content of the material that was revealed, they are getting poor advice. I'm sure that the items that have been published so far have indeed been taken out of context, as they contend, but is that not the standard claim by nearly everyone who has suffered a similarly embarrassing exposure in the last couple of decades? The response of the University of East Anglia to date is simply inadequate in the modern era of information, and if I were in their shoes I'd at least announce a full and immediate academic inquiry into whether the emails have unearthed practices that were contrary to university policies and the normal standards of data integrity and peer review. They'd be much better off tackling this proactively than waiting for it to be forced upon them, or taken out of their hands as a result of a Question asked in Parliament--however unlikely that might be in the current political climate.

Next, consider email as a medium of discussion. In my career I have seen many emails that their senders would have subsequently preferred to see deleted from all systems, and I have probably written one or two myself. But that's not the reality of a world in which anything you write on a networked system can be divulged later as part of the discovery phase of a lawsuit or in a government investigation. The best advice I've heard on the subject is the lesson some of the authors of the Hadley emails have just learned the hard way: "Don't write anything you'd be embarrassed to see printed on the front page of the New York (or in this case the London) Times."

That doesn't mean I'm naive about how people--even scientists--interact with each other. Anyone who has spent five minutes peering behind the veil of academic politics wouldn't be terribly surprised at some of the caustic, small-minded, and downright vindictive comments that pepper the Hadley emails that have turned up around the Internet. Nevertheless, most of us aren't involved in work that is integral to a global effort to understand and avert the worst outcomes of something on the scale of climate change. These folks are expected to hold themselves to a higher standard, and if they don't, it jeopardizes not just their own reputations but the public's perception of the findings of the larger body of climate science. When I read an email in which one noted climate researcher asks another not to refer to a particular subject in his reply, but just say yes or no, or another indicating the author would delete some data points from a graph showing a recent change in the trend, I'm reminded of some precautionary advice I received at the very beginning of my oil trading career: "Avoid even the appearance of evil."

The basic issue here that many of those responding from the climate change community seem unable or unwilling to grasp is that their real problem is not how particular individuals or groups might exploit this information, but how the information itself could undermine the faith of the public in the integrity of climate science. I use the word faith deliberately, because for most of us it boils down to that. The number of people actually equipped to read the scientific papers in question and ascertain whether the manipulation of charts and data implicated in some of the leaked emails is serious or not is vanishingly small, compared to the much larger number of us who must simply take it on faith that the scientists studying the climate and reporting on alarming changes in it are behaving in a fair, transparent, and unself-interested way, to the greatest extent humanly possible. It would be hard for most of us to read the emails in question objectively and not have that faith shaken, at least a bit.

Now, it's possible this entire episode could blow over in a news cycle or two and have no impact on the impending negotiations in Copenhagen or on the Congressional debate on climate legislation. I wouldn't bet on that, because what little has come out so far fits neatly into the preexisting view by some of climate science as a conspiracy, or at least a process that has been politicized by the funding and bureaucratic power that large sums devoted to climate research have bestowed. If the climate science community wants to put this episode behind it without derailing the public's trust in the scientific consensus on global warming, then the researchers and institutions that are leading this effort should be calling loudly for a full airing of Hadley's linen, and an assessment of the center's practices by an unbiased panel, preferably one well-staffed with scientists from other disciplines. Any perception of a cover-up will only reinforce suspicions that conduct at Hadley wasn't what it should have been, and that at least one pillar of the climate change argument looks shakier than it did just a week ago.

Friday, November 20, 2009

My critique of a proposal for expanded tax credits to promote the electrification of transportation prompted some interesting comments. It also got me thinking again about an underlying problem that leads to the kind of scramble for government favor and largess that is exemplified by such efforts and by the badly-flawed Waxman-Markey climate bill. We have seen endless debates on energy policy, energy strategy and energy tactics, but far too little on energy principles. It would save much time, effort and money if we had a guiding principle that eschewed favoritism toward any particular technology, in favor of technology-neutral regulations and federal investments in broadly-useful energy infrastructure. Even more importantly, we would benefit from a clear principle of focusing policy and incentives on our desired ultimate outcomes, such as reducing emissions or oil imports, rather than on individual pathways for achieving them.

Take the example of electric vehicles (EVs) and their infrastructure. The US government has no business promoting a single-focus solution like this. It does, however, have a vital interest in promoting much more energy-efficient cars, based on any technologies that achieve that result. If handing out consumer tax incentives for new cars is necessary to further that goal, they should be given on the basis of total energy consumption, using a comprehensive metric like the MPGe of the Automotive X-Prize, which counts all energy in all forms delivered to the car. The higher the MPGe, the bigger the incentive. That would make a lot more sense than doling out tax credits in proportion to the size of a car's battery. Along with the proposal by the EPA and Department of Transportation to let carmakers count EVs twice towards their new corporate fuel economy and tailpipe emissions targets, that would create a perverse incentive similar to the old "SUV Loophole", possibly setting the stage for a new generation of large, inefficient battery SUVs.

Shifting transportation energy from oil to electricity makes more sense if that electricity is used efficiently, particularly since low-emission sources still account for less than 1/3 of our electricity supply, and the wind power most often mentioned in connection with powering EVs accounts for just 1.6% of US generation this year. On that basis, investments in the smart grid and long-distance transmission lines would probably be as helpful in supporting future EV deployment as underwriting specific EV recharging infrastructure, while avoiding the risk of becoming orphaned if EVs don't catch on.

On the generation side, whether intentionally or not, the stimulus bill passed early this year helped put wind, solar, and other renewable energy sources on a more technology-neutral basis by making them all eligible for the same 30% federal tax credit previously available only to solar power. Yet this provision still contains at least one glaring omission, because it was established under a very specific definition of renewable energy, rather than encompassing all energy sources meeting criteria for very low emissions that would also include nuclear power. Putting nuclear and renewables on a common footing would go a long way toward ending protracted arguments about which technology receives more (undeserved) government support and which is most commercially competitive, and it would foster a future generating mix offering similar depth and flexibility to the one we have now, without undesirable greenhouse gases.

Ultimately, whether you like my choice of principles or prefer different ones, we need a common set of criteria for making the energy decisions we face, instead of treating each as an ad hoc opportunity for one option or technology and its backers to win at the expense of the others--and often at the expense of taxpayers. While we certainly need to get on with deploying lower-emission ways of producing and using energy, it is premature to bet the ranch on any one option. We should still be creating new options and pruning them along the way, based on principles aligned with the basic problems we are trying to solve. While that might sound idealistic to some, it strikes me as intensely practical and much more useful in the long run than the prevailing plague of energy "answer-itis", in which everyone wants to push a specific answer before we even agree on the right questions to ask.

Wednesday, November 18, 2009

Perhaps it's merely a sign of the times, when a billion is the new million and firms in many industries have found it easier to get capital from the government than from bankers, bondholders and shareholders, but the price tag implicit in the recommendations of a new cross-industry group formed to promote electric vehicles is startling even in this context. Although I couldn't find the total anywhere in the lengthy report from the Electrification Coalition, the Washington Post tallied the combined cost of their proposals at $124 billion in new government incentives, over and above the billions already being spent under the stimulus bill and other programs to support the R&D, manufacturing, and infrastructure for plug-in electric cars, and to subsidize consumer purchases of them. The frustrating part of this is that I'm in general agreement that electric vehicles probably represent the long-term future of cars. However, I don't believe anyone can know this with sufficient certainty, any more than they knew a few years ago that fuel cell cars were the answer, or in the late 1990s that diesel hybrids were the answer. The report also raises basic questions about how new industries should be built, and at whose expense.

Without dissecting the entire document, the justification for its recommendations appears to hinge on a few key arguments concerning our current use of oil, which the Coalition is hardly alone in regarding as excessive. Although they go a bit overboard focusing on the $900 billion Americans spent on petroleum products last year--roughly half of which represented the value of domestic production, refining margins, and federal, state and local taxes collected on product sales, all of which are part of GDP and thus a plus, not a minus for the economy--they eventually get around to mentioning last year's oil import tab of $388 billion. (That figure is currently running at around $250 billion per year, based on the September refiner acquisition price applied to our average monthly net imports, but it is still a lot of money.) Yet as attention-focusing as that sum is, vehicle electrification is hardly the only way to go about reducing it, and from what I can tell it is almost certainly not the most cost-effective means of doing so.

Aside from the diesel options I discussed the other day, there are a variety of strategies available to improve fuel economy significantly without merely shifting our transportation energy consumption from one category (oil) to another (electricity generated from a mix anchored by coal.) Our approach to reducing oil consumption must also take into account the diminishing returns to increasing fuel economy. Doubling the average car's fuel economy from 25 mpg to 50 mpg saves twice as much gasoline as going from 50 mpg to 100 mpg--and it still saves more than achieving the fancifully hyperbolic mpgs we've seen quoted for various plug-ins and EVs that ignore the energy required to generate grid electricity. The avoided fuel cost effectively sets a ceiling on the financial rewards available from the notional fuel economy of grid-based vehicles. Because fuel savings can't justify today's high up-front cost of battery-powered cars, the Coalition proposes consumer tax credits for plug-in hybrids or EVs that could top $10,000, compared to the current $7,500 maximum. By comparison, for ten grand you could fuel a Prius for 100,000 miles at $5/gallon, or a pair of them at current gas prices.

Nor do I find the suggestion of providing federal tax credits to cover 75% of the cost of EV-recharging infrastructure (50% in later phases) appealing, other than as a gift to the member companies of the Coalition that paid for this study. Infrastructure is an expensive investment, and I'm quite familiar from my experience of the EV-1 rollout with its importance in breaking the chicken-and-egg market dynamic associated with battery cars. However, I don't see sufficient justification for taxpayers to pick up this much of the tab--and risk--for infrastructure for which the demand will be so small and uncertain for years to come.

Even measured against the scale of the bailouts of GM, Chrysler, and the big banks, $124 billion is a huge price tag to impose on taxpayers who have just begun to wake up to the likely consequences of the enormous debts that our deficits are piling up. While vehicle electrification might reduce our trade deficit in oil, it's not obvious that it won't replace it with offsetting deficits in cars, batteries and the scarce strategic materials they require. Nor does it seem equitable to ask average taxpayers to furnish other, perhaps higher-quintile taxpayers with EV tax credits so generous that they would exceed the depreciated value of the average car on the road.

I'm not opposed to electrification or the companies behind this initiative. In fact, I wish them well and look forward to someday having the choice of buying an attractive and affordable electric car. What I do oppose is another massive handout to another chosen industry on the basis of a highly uncertain scenario of future market development, bypassing all of the competitive pressures that should shape such a revolutionary change along the way. The first few million grid-powered EVs would have a negligible impact on the nation's energy consumption, emissions, and oil imports, yet even their advocates suggest they will cost a bloody fortune to put on the road. As you read the Coalition's analysis and their proposals for who should foot the bill for all this, I encourage you to consider who stands to benefit the most from it in the next ten years. Taxpayers should insist that the early adopters and the companies that will garner most of the value of these developments pay their own way, as was the case for personal computers, cellphones, and most other successful new technologies of the last several decades.

Monday, November 16, 2009

Although oil trading hasn't been my primary focus for many years, the recent announcement by Saudi Aramco that it is switching its price mechanism for oil delivered to the US caught my attention. Instead of basing its formula for deliveries here on the price of West Texas Intermediate crude oil, it will apparently reference the new Argus Sour Crude Index (ASCI.) While that lends substantial credibility to this new index and may gain Argus more than a few new subscribers, the implications for the widely-traded NYMEX WTI contract and the dynamics of the broader international oil market seem much less clear. In particular, I am skeptical of suggestions that this move could ultimately reduce whatever influence non-commercial financial participants--speculators, in common parlance--have on oil prices.

The question of how best to price crude oil for buyers and sellers is a perennial problem, particularly for oil that differs significantly in quality from the light, sweet grades behind the extremely liquid WTI and ICE Brent futures contracts. US refiners, in particular, have invested many billions of dollars in the hardware required to turn lower-quality oil into high-quality petroleum products. Any time the peculiarities of these contracts drag up the prices of the grades of oil they prefer to run, they grumble about basing deals on WTI. Likewise for sellers of sour crude, foreign and domestic, who suffer when the WTI price moves out of sync with world prices, such as when storage at its nexus at Cushing, OK fills up, as it did earlier this year. However, after listening to the Q&A podcast concerning the ASCI on Argus's website and reading the background document there, I'm skeptical that this index will settle the sour crude market's discontent, because it won't change the way this oil is traded by nearly as much as it might appear.

Without getting into all of its details, as I understand it the ASCI is effectively a composite daily report of the deals done for three specific streams of offshore Gulf of Mexico crude oil, all of which trade at a differential to WTI. In calculating a daily price, Argus will add the average daily discount or premium vs. WTI from the transactions it learns of to the daily price for WTI to come up with a single price in dollars per barrel. The Argus podcast was very clear that NYMEX WTI is still as the heart of the new index, not just because this reflects the way deals are done with reference to WTI, but also because WTI remains the highly-liquid futures contract that the buyers and sellers of the ASCI oil streams use to hedge their market risk. In other words, the new ASCI index is not a substitute for WTI-based pricing, but merely a more transparent gauge of the relationship between WTI and the sour crude market--though an index you have to pay to read falls a bit short of the kind of transparency currently provided by WTI itself.

What would happen if speculators drove up the price of WTI by $30/bbl? In theory, ASCI would reflect any disconnection between the fundamentals-based pricing of its included sour crude streams and the financially-driven WTI market by remaining more or less unchanged, after summing the combination of correspondingly wider discounts for the ASCI grades to the inflated daily WTI prices. Only by looking at the differentials themselves would we see any indication of distortion of the market by non-commercial players. But is that realistic? Consider that between January 2007 and July 2008, when the price of WTI rose more or less steadily from the mid-$50s to nearly $150/bbl, the discount between WTI and the monthly average refiner acquisition price for imported crude only widened from around $4.75/bbl to roughly $9/bbl. If WTI was being driven by speculation in that interval, differentials-based trading of the kind that ASCI will measure hardly insulated refiners from its effects.

That historical result might merely indicate that speculation had little real effect on the market in that period--a view to which I'm sympathetic--but it might just reflect the inertia of negotiated crude differentials. Either way, if you're Saudi Aramco and you're selling crude into the US based on ASCI, I'd conclude that your prices would still go up more or less in tandem with the NYMEX, despite the superficial "arms-length" mechanism flowing through ASCI. Perhaps I've missed some subtlety in the mechanism.

From what I can tell, neither ASCI nor the prospect of new futures contracts based on it addresses the underlying concerns I have had since the industry migrated to pricing based on differentials against the WTI and Brent futures contracts, and away from negotiating actual "fixed and flat" prices for each cargo or pipeline deal, back when I was trading oil in the 1980s and early 1990s. While that shift made life much easier for risk managers and took a lot of heat off traders to strike the best deal on any given day, it also opened the door to a host of other influences on pricing that I still don't think we entirely understand.

The market will pass its own judgment on ASCI and other new tools like it. If it proves useful to traders and risk managers, it could become the new industry standard, as Argus must hope, having made such a big splash over its launch. If it's not useful, it will fade into the background, becoming just another dataset in an already bewildering sea of energy-related information. With Gulf of Mexico output booming and more discoveries yet to be made, it looks like a reasonable bet to join other useful physical crude indices around the world. But anyone hoping it will shine a beacon on speculators in the next oil price spike is likely to be disappointed by the core of a system still rooted in WTI, the speculative influences over which remain uncertain and possibly unprovable.